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SAN FRANCISCO (Reuters) - To prevent more fiscal turmoil, California needs a tax system that relies more on revenue from sales, including sales of services, than on its wealthy taxpayers' income taxes, according to a new report.
State leaders are nearing a June 15 deadline for approving a state budget but remain divided over whether to extend temporary tax hikes, including one on the state sales tax, to help fill a roughly $10 billion gap -- a near-term task crowding out debate about systemic fiscal challenges like the state's volatile revenue.
"California could reduce its revenue volatility and improve its business climate by moving toward a greater reliance on consumption taxes -- those based on goods or services consumed in the state rather than on income earned here," according to the Public Policy Institute of California report.
"Revenue from a broad-based consumption tax would likely be more stable because consumption tends to fluctuate less than income," the report added.
California's sales tax applies to sales of tangible property, merchandise, fuel, food in restaurants and alcoholic beverages, and households pay about two-thirds of it.
While taxing services, which make up about two-thirds of U.S. economic activity, could help stabilize California's revenue, its leaders will likely see the idea as radioactive.
That's because proposals for taxing services poll poorly with the same voters who say the state's budget woes make them -- and many in Washington, on Wall Street and within the $2.9 trillion U.S. municipal debt market -- anxious.
Mark DiCamillo of The Field Poll said his polling firm recorded only 25 percent of voters in an April 2009 survey saying the state should expand sales taxes to services and goods that are not already taxed. The idea received the least support of the dozen tax options the firm asked about.
"It was not well received to say the least," said DiCamillo, director of The Field Poll.
The institute's report faces a chilly reception in the state capital of Sacramento, which banks on a few taxpayers to prop up the state's finances with receipts from personal income taxes, the state's most important source of revenue.
The state's finance experts see revenue from personal income taxes providing 57 percent of general fund revenue for the fiscal year beginning in July. Revenue from sales taxes is seen making up a quarter of general fund revenue next year.
In 2009, the top 1 percent of California taxpayers generated just under 37 percent of state revenue from personal income taxes compared with just over 48 percent in 2007 and nearly 49 percent in 2000 at the peak of the dot-com boom, according to California's department of finance.
Those figures underscore how stock market downturns hit a small but pivotal segment of taxpayers and how that can roil the finances of the most populous U.S. state's government.
"When the market tanks, these taxpayers sneeze and the state catches a cold if not pneumonia," said H.D. Palmer, a spokesman for the state's finance department.
But when their income grows, the state's fiscal outlook brightens considerably. Governor Jerry Brown, for instance, in May unveiled a budget plan that narrowed the state's deficit to about $10 billion from $15 billion with the expectation that stronger capital gains will help lift revenue by $6.6 billion.
Revenue volatility is working in California's favor at the moment, said Alan Auerbach, author of the institute's report.
"It's one of the reasons why revenues have been going up so quickly," said Auerbach, an institute fellow and director of the University of California, Berkeley's Burch Center for Tax Policy and Public Finance.
Despite the volatility of California's revenue, University of California, San Diego political scientist Thad Kousser does not see a groundswell for revising the state's tax system.
Democratic lawmakers are wedded to a progressive income tax. Republicans don't want to be linked to any kind of tax scheme. Volatility is too abstract an issue for most voters.
"I don't see Californians gathering around the state with pitchforks to march on the Capitol due to volatility," said Kousser. "Voters aren't mad about revenue volatility. Voters are mad about what revenue volatility sometimes leads to. They hate late budgets. They hate budget deficits."
Editing by James Dalgleish